Public pensioners have taxpayers as a backstop

Although government plans have taken a hit, benefits mostly secure

WASHINGTON (MarketWatch) -- When it comes to retirement security, it pays to have something that is good enough for government work.

While private-sector workers can only hope their 401(k)s and IRAs recoup their big losses of the last year, government employees are at less financial risk because their pensions are generally guaranteed by law -- with taxpayers on the hook for benefits.

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"Pensioners aren't going to be pained in the short run," said Steven Foresti, managing director with Wilshire Consulting and head of the investment research group.

That doesn't mean the financial crisis hasn't taken a toll on the pension plans of state and local government workers. Funding levels for public pension plans have dropped, and are expected to fall even further as more investment losses are recognized, experts said.

"What plans have working for them is they are long-term propositions, there's time to make up for losses. But it is naïve to think that costs haven't increased because of the cycle we've been through -- there are long-run consequences," Foresti said. See MarketWatch's complete coverage of Retirement in Peril.

A pension plan's funding ratio measures assets to liabilities. For fiscal 2008, Wilshire estimated that the funding ratio for state retirement systems fell to 84% from 96% in the prior year. For 2009, Foresti expects a level of less than 80%. But experts say retirees and already-vested workers can rely on plans to honor promises.

"Current employees are guaranteed benefits by contract law and many state constitutions mandate that benefits cannot be changed," said Richard Ferlauto, director of corporate governance and pension investment at the American Federation of State, County, and Municipal Employees. "Current workers would challenge any attempt to illegally deny them benefits that they expect and deserve."

There are about 7.5 million beneficiaries receiving payouts from state and local retirement systems, another 14.4 million employees who are system members, and 4.2 former employees and others who have retained retirement credits, according to 2007 Census data. Among the two primary types of federal retirement -- the Civil Service Retirement System and the Federal Employees Retirement System -- there are about 1.86 million annuitants, and 610,000 survivor annuitants, as of Oct. 1, 2008, according to the U.S. Office of Personnel Management.

Newer employees may take a hit

While those who have retired or are vested can feel reasonably secure, the news may be less optimistic for newer workers, experts said. Newer public workers face smaller benefits as more governments establish tiered benefits systems, said Keith Brainard, research director of the National Association of State Retirement Administrators.

"It's more typical to see benefit changes made to new hires, and that's a way to reduce the cost of the plan," Brainard said. "We are likely to continue to see those develop."

Foresti agreed: "As different states or municipalities are looking at their particular situation, what their tax base looks like, there is going to be some pressure to change what's in the benefits package."

A retirement system could even convert from a defined-benefit to a defined- contribution plan, Ferlauto said.

"That would put security at risk," Ferlauto said. "For people who are not vested, or more likely for new employees, the terms of the contract could change in a way that would make them a lot less secure."

According to a report from the National Conference of State Legislatures, this year's "principal theme" in pension legislation "was the need to make future pension costs manageable in the light of states' straitened fiscal circumstances and the enormous losses most retirement trust funds have experienced."

The report said:

Few benefit increases were enacted

There were various forms of reductions in states

Some states enacted early retirement incentives to reduce work forces

Some states revised benefit packages for future employees to require longer service or higher ages for retirement, discourage early retirement even with reduced benefits, limit future cost-of-living adjustments, and tighten standards for disability retirement.

"For the most part benefits cannot be rolled back for current retirees or employees, so changes would affect new employees," Ferlauto said. "Most changes would involve increasing the employee contributions into the system, or raising the retirement age, which is happening in a number of places."

Beth Almeida, executive director of the National Institute on Retirement Security, said public pensions were "in really good shape" before the crisis hit, but some administrators are reviewing plans.

"They had plenty of money to pay for benefits for decades," Almeida said. "That said, there is a process going on where states and localities are taking a look at their pension programs, and making sure that the plans are sustainable for the next 50 years."

Despite the market's volatility, there have been some cool heads, she added.

"What we are really seeing around the country are not knee-jerk reactions to dramatic events. You are seeing a more deliberative reaction," Almeida said. "The public pensions have been through market cycles before. They know that they are going to have some good times and some bad times."

Pressure on taxpayers

While many workers are protected by pension contracts, taxpayers may be forced to foot more of the bill in the near- and long-term -- or watch some government services get eroded -- as investments gone awry exert even more pressure on pension systems. According to the report from the National Conference of State Legislatures, states such as Nebraska and New Mexico have increased contribution rates for "a number of state-sponsored retirement plans for both employers and existing employees."

"The bad news for stakeholders, like taxpayers, are the costs of meeting benefits in the future," Foresti said. "You'd expect those to be higher now. The shortfall needs to be filled in in the form of higher contributions. It's not reasonable to assume that investment returns are going to take care of everything."

Contributions to public pension systems typically come from three groups: employers, employees, and investment returns.

"Given this shared funding model, it's logical that recovering from recent investment losses may require shared sacrifice," Almeida said. "This may mean re-examining contributions coming into the system or benefits coming out of the system."

Healthy pensions need to achieve a certain return over the long run to keep costs at a reasonable level for taxpayers.

"Because of the booming stock market in years past some government employees thought that they could bypass regular contributions into the pension systems," Ferlauto said. "For states that properly paid their annual contributions we expect little long-term impact on tax rates, for states that avoided contributions when they should have been made there is a need for more tax dollars, but that is to make up for dollars that should have gone into the systems."

While a fully-funded plan is not necessary to pay promised benefits for many years, such a goal helps smooth taxpayers' expenses over time, Brainard said.

"If you are extremely underfunded, the cost of carrying that can be large and burden future taxpayers," Brainard said. "Full funding is not conservative. It is appropriate. It helps to promote intergenerational equity."

Robert Wylie, executive director of the South Dakota Retirement System, said his state has a conservative investment approach to ensure that benefits don't grow faster than assets. However, administrators may have to slow down benefit increases -- an option that many other plans don't have, he said.

"It might be in a few pieces so that not one group is feeling all of the pain," Wylie said.

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